Marty Whitman's first principles of value investing

April-22-2008
Marty Whitman's "Strategy"by Todd Sullivan
Regular readers kow I am a fan of Whitman and hold a position in his Third Avenue Value Fund (TAVFX). Considering the funds 15% annual return since 1990, it just may pay to listen to what he has to say. In a shareholder letter, Whitman disclosed the five elements he says are the key to his success.

They are: buy cheap, buy quality, buy to hold, buy with minimal expenses, and buy without leverage (margin).

*Buy to hold: Stick with the stock and do not sell just because the price drops. Unless, “there has occurred a permanent impairment in underlying value" of a stock.

*Buy with minimal expenses: Reduce taxes and trading costs by having the patience and confidence to hold. One of the largest drains on investments not considered by investors are commissions and taxes. For example: An investor has a stock that goes from $10 to $20 and sells. His return is $10, correct? No. Assuming he is in the 28% tax bracket his actual return on the sale is $7.20 ($10 - 28%) after taxes and even less when commissions are factored in. If he decides to buy the stock back he must wait for an in excess of $2.80 a share drop in order for the trading to be worth it.

*Buy without leverage: Means do not use margin. “While leverage can increase your returns in good times,” he says , “it will dramatically increase your losses in bad times.” Much of the recent angst of investors at Bear Sterns (BSC), Merrill Lynch (MER) and other banks has been due to excessive leverage. Too much leads to forced selling into depressed markets and destroys returns.

*Buying cheap: Cheap, or, “issues at prices that reflect substantial discounts from readily ascertainable NAVs (net asset values) … (and whose) NAVs will increase by not less than 10% per year compounded".

*Buying quality: Whitman defines it as a strong financial position, competent management, and a business that is “understandable … plus lots of cash and a high level of insider ownership … with some type of competitive advantage”. A very Buffett like strategy and a very simple one filled with common sense. For more on Whitman's thinking, visit the Fund's site here.